Yesterday, BlackRock’s Chairman and CEO Larry Fink issued his annual letter to public company chief executives. BlackRock is a global investment management company, the world's largest, with almost $7 trillion in assets under management as of September 2019. This year’s letter conveys several important messages that are worth noting by those responsible for corporate strategy-setting, policy and public reporting. Although he has been an advocate for sustainable investing for some time, the letter is Mr. Fink’s strongest advocacy yet for investments with strong environmental, social and governance (ESG) components.
Climate Risk Is Investment Risk
Mr. Fink’s message gains traction with his assertion that the evidence on climate risk is compelling enough for investors to reassess their core assumptions about modern finance and reiterates that is exactly what BlackRock intends to do. He states that markets have been slow to adjust to the risk that climate change presents to economic growth and prosperity and the related effects on the long-term prospects of issuers. To illustrate, he cites several questions:
- Will cities be able to afford their infrastructure needs as climate risk reshapes the market for municipal bonds?
- What will happen to the 30-year mortgage – a key building block of finance – if lenders can’t estimate the impact of climate risk over such a long timeline, and if there is no viable market for flood or fire insurance in impacted areas?
- What happens to inflation, and in turn interest rates, if the cost of food climbs due to drought and flooding?
- How can we model economic growth if emerging markets see their productivity decline due to extreme heat and other climate impacts?
As investors raise these and other questions with the objective of assessing the necessary adjustments to their investment portfolios in light of concerns about the impact of climate policy on asset values, cost structure, and market demand, Mr. Fink warns that “we will see changes in capital allocation more quickly than we see changes to the climate itself. In the near future – and sooner than most anticipate – there will be a significant reallocation of capital.”
Needless to say, regardless of one’s political persuasion or views on global warming, this a strong action-oriented message. To hit the proverbial rubber on the road, BlackRock announced in its annual letter to clients a number of initiatives to place sustainability at the forefront of its investing philosophy. The letter expresses BlackRock’s intent to:
- Strengthen the integration of sustainability considerations into its discretionary active investing processes;
- Reduce ESG risk by exiting investments that present a high sustainability-related risk, such as thermal coal producers and companies with more than 25% of their revenues from thermal coal production (a modification to investment portfolios BlackRock intends to complete by mid-2020);
- Expand its offerings of investment products such as ESG iShares that screen fossil fuels; and
- Enhance transparency of its investment stewardship practices, including disclosure of sustainability characteristics for BlackRock mutual funds so investors are able to see clearly the sustainability risks of their investments.
Change Takes Time
Mr. Fink suggested that investors cannot act alone in effecting a low-carbon economy. Both governments and the private sector must function in a coordinated, international response aligned with the Paris Agreement. He views the goal being the achievement of an energy transition that is fair and just to developing countries as well as those segments of society that are displaced as certain sectors fall out of favor. According to Mr. Fink, this transition will unfold over decades as the technology does not yet exist to cost-effectively replace many of today’s essential uses of fossil fuels. Accordingly, there are economic, scientific, social and political realities that must be considered in facing what he calls “the ultimate long-term problem.” But the business realities are indisputable – every government, company and shareholder must confront climate change starting now.
ESG Is the Pathway to a Long-Term View
Mr. Fink argues that “all investors, along with regulators, insurers, and the public, need a clearer picture of how companies are managing sustainability-related questions.” To that end, he embraces the notion of stakeholder interests, including employees, suppliers, customers and the communities in which companies operate. His point is that “each company’s prospects for growth are inextricable from its ability to operate sustainably and serve its full set of stakeholders.” This perspective, of necessity, forces a longer-term view.
Companies that focus on maximizing returns in the short term and engage in acts of commission or omission that damage society are eventually exposed and ultimately suffer loss of shareholder value. By contrast, a strong sense of purpose and a commitment to stakeholders help a company connect more deeply to its customers and adjust to the changing demands of society. Ultimately, Mr. Fink concludes, purpose is the engine of long-term profitability. His bottom line: companies and countries that do not respond to stakeholders and address sustainability risks will encounter growing market skepticism and a higher cost of capital.
Many companies report on sustainability, but Mr. Fink argues for a more widespread, standardized adoption. Acknowledging that no framework is perfect, he points to BlackRock’s support for the standards of the Sustainability Accounting Standards Board (SASB). Specifically, BlackRock is acting as a de facto regulator by requesting each company in which it invests to:
- Publish a disclosure that is in line with industry specific SASB guidelines by its respective year-end, if it has not already done so, or disclose a similar set of data in a way that is relevant to its particular business; and
- Disclose climate-related risks in line with the Task Force on Climate-Related Financial Disclosures (TCFD) recommendations, if it has not already done so, along with its plan for operating under a scenario where the Paris Agreement’s goal of limiting global warming to less than two degrees Celsius is fully realized, as expressed by the TCFD guidelines.
Last year, BlackRock voted against or withheld votes from 4,800 directors at 2,700 different companies. Mr. Fink observed that if companies and their boards are not producing effective sustainability disclosures or are not making sufficient progress on material sustainability-related issues, BlackRock will hold them accountable by voting against management and board directors. This is as explicit as it gets.
Concluding Thoughts – What the Letter Means to Companies
As markets continue to debate the issues of corporate purpose and the scale and scope of necessary governmental and corporate action on climate change, the BlackRock letter draws a line in the sand that cannot be ignored. Mr. Fink’s message is one of pragmatism in recognizing the long-tern nature of the challenge but also one of urgency in that it’s time for the public and private sectors to act. The specter of capital reallocation is very real. If other asset managers – Vanguard, Fidelity and State Street, for example – follow suit with similar actions, it’s a game changer.
If they haven’t already, companies need to take a look at their sustainability reporting practices. In particular, they should assess the gaps, if any, between their current reports and the SASB standards. If significant, the gaps should be considered in improving the company’s disclosures. In the absence of robust disclosures, Mr. Fink warns that investors, including BlackRock, will increasingly conclude that companies are not adequately managing risk and modify their portfolios accordingly.
 “A Fundamental Reshaping of Finance,” Larry Fink, Chairman and CEO of BlackRock, January 14, 2020.
 “Sustainability as BlackRock’s New Standard for Investing,” BlackRock, January 14, 2018.